Explain the Rationale for the Existence of Supplier Induced Demand in Health Care

Introduction: In the traditional market, consumers decide how much to consume and suppliers decide how much to supply and prices coordinate the decisions. For perfect competition it is assumed inter alia that there is: perfect information so that individuals are fully informed about prices, qualities etc; a lot of buyers and sellers; no single buyer or seller that has influence on the price.
But health care market falls short of the perfect market paradigm as it is dogged by many phenomena that cause it to fail (Arrow 1963). One such phenomenon is supplier-induced demand (SID), whereby health care providers, usually physicians, exploit their information advantage over patients in order to induce patients to utilize more healthcare services than they would if they were accurately informed. The phenomenon of SID tends to take an important place within social debates because it has an impact on health care expenditures, health status and the allocation of income between patients and physicians (Labelle et al 1994).

Therefore, it has attracted considerable attention in the health economics literature since Roemer (1961), who observed a positive correlation between the number of hospital beds available and their use leading to the observation, ‘a bed built is a bed filled’, sometimes referred to as Roemer’s Law. Although a variety of empirical tests of SID have been reported in literature, researchers disagree on the definition of and tests for SID. The validity of the results from the tests is controversial.
Therefore there is no consensus on the development and implementation of public policy based on these results (Labelle et al 1994, p349). Indeed, Doessel (1995, p. 58) observed that this area of research can be described as a theoretical and empirical quagmire. After defining the terms, this essay is going to explore and explain the theoretical rationale, the empirical evidence and policy implications for the existence of SID. The argument will be summed up in the conclusion. Health Care Market and SID
A market is a shorthand expression for the process by which households’ decisions about consumption of alternative goods, firms’ decisions about what and how to produce, and workers’ decisions about how much and for whom to work are all reconciled by adjustment of prices. Health care comprises services of health care professionals, which are addressed at health promotion, prevention of illnesses and injury, monitoring of health, maintenance of health, and treatment of disease, disorders, and injuries in order to obtain cure or, failing that, optimum comfort and function (quality of life) (Worldbank website).
In health care market there is: a few buyers and sellers; asymmetry of information therefore violation of consumer sovereignty; allocation of resources by physicians and not price mechanism etc. Therefore patients face a dilemma in translating their desire for good health into a demand for medical care. This requires both information and medical knowledge, which they usually do not have. There is no definitive and widely accepted definition of SID. In literature, the definitions range from positive and value free (Fuchs 1978) to normative with negative connotations (Folland et al 2001, p. 04). McGuire (2000, p504) says that SID ‘exists when the physician influences a patient’s demand for care against the physician’s interpretation of the best interest of the patient’. Labelle et al (1994, p. 363) point out the need to incorporate in the definition of SID both the effectiveness of the agency relationship and the effectiveness of the induced services. This means that inducement can give rise to ‘good’ or ‘bad’ outcomes for patients depending on its clinical effectiveness, e. g. f a doctor persuades a patient to undertake more treatment where the patient would otherwise have opted for a less than clinically effective package of care. Rationale for the existence of SID: The theoretical analysis of SID is based upon the assumption that doctors maximise their utility subject to income and inducement. Dranove (1988, p 281) argues that under certain conditions the physician will have an incentive to recommend treatments whose costs outweigh their medical benefits. SID involves a shift of the demand curve, such that as supply ncreases, demand also increases (Fig. 1). In practice the exact demand curves themselves cannot be measured. Only the equilibrium points (A, B, C and D) of the overall market can be observed. If the supply of doctors increases from Q1 to Q2 (Fig. 1a), then the fee payable decreases from P1 to P2. But if SID exists (Fig. 1b), as the number of doctors increases from Q1 to Q2 the doctor would keep shifting the demand curve from D through to D3 in order to maintain or increase income. Fig. 1: Graphical representation of competing hypotheses
The potential for SID to arise is shaped but not guaranteed by a number of characteristics of the health care market including: information gaps and asymmetries which encourage patients to seek medical advice and delegate decision-making to doctors; potential weaknesses in the agency relationship and the impact of clinical uncertainty on the decision making processes of doctors. Systems for financing, organising and paying for medical services also influence doctor and patient behaviour.
The asymmetry of information between user and provider is the most fundamental peculiarity of health care, and the source of the most serious failures of market processes during resource allocation. Informational asymmetries may also invalidate the assumption of “consumer sovereignty” which underlies evaluative policy assessment in much of economics. Patients will often be relatively poorly informed compared with their doctor about their condition, treatment options, expected outcomes and likely costs. Unlike other professional services, information asymmetry is most pronounced in health care markets.
Many researchers have tested the hypothesis that more knowledgeable patients should be resistant to SID and that they should therefore make less use of medical care. Surprisingly these studies have consistently found that knowledgeable patients frequently use more care [Bunker and Brown (1974); Hay and Leahy (1982) and Kenkel (1990)]. The institutional responses to information asymmetry are professionalisation, self-regulation, and the development of an agency relation between individual transactors and between the professions and society collectively.
Agency relationship is formed whenever a principal (patient) delegates decision-making authority to another party, the agent (doctor). Ill-informed consumers are protected, by provider advice, from consumption of unnecessary or harmful services (inappropriate or poor quality) and also from failure to consume needed services. If this agency relationship were perfect, doctor would take on entirely the patient’s point of view and act as if he/she were the patient. All consumption choices made for the patient by the provider would be made so as to maximize the patient’s (and ultimately society’s) utility function.
Health care providers do not always act as perfect agents for their patients. Their recommendations are sometimes influenced by self-interest, or the interest of the organization for which they work. This imperfect agency arises because the doctor (agent) performs a dual role — the same person who provides advice about a treatment usually provides and receives payment for that treatment. Hence, demand is no longer independent of supply; the agent can shift the demand curve to any position (Fig. 1b).
The demand curve (Figure 1a), assumes that independent consumers of care are not directly influenced by suppliers in their decisions to use care, or alternatively that if such direct influence exists, its level is determined external to the market process itself. On the other hand, it has been shown that in spite of the presumed physician influence over the patient, the physician cannot predict the level of patient compliance (Goldberg et al 1998). Therefore it is doubtful how much influence the physician wields over the patient when it comes to SID.
Traditionally doctors’ behaviour is controlled by a professional code- “Hippocratic oath”. Financial self-interest on the part of the physicians is only one of the causes of imperfect agency. Another very important cause is the failure of physicians to understand or accept patients’ preferences regarding the impact of health status on utility and provide this information to the patient (Labelle et al 1994). The target income theory posits that as the number of physicians has increased, they have induced additional demand to get a particular income, e. g. y increasing the volume and variety of tests and procedures. This is in contrast with conventional economics where increasing supply lowers the price for the consumer. The target income is determined by the local income distribution (Rizzo and Blumenthal, 1996). A professional service like Health care is inherently heterogeneous and nonretradable. A monopolistic competitor selling a nonretradable service sets a quantity to maximize profit and unless there is some cost to inducement, a physician or dental practitioner pursuing net income would induce demand to an infinite extent (Gaynor 1994).
However, physicians prefer not to induce demand and only do so if they are compensated by adequate gains in income. The utility maximisation of physicians is limited by disutility of discretion, i. e. either the physician’s internal conscience (Evans 1974; Mcguire and Pauly 1991) or as a result of a reputation process by which doctors who excessively induce demand are punished through future reductions in true patient demand (Dranove 1988). SID can arise when clinical uncertainty causes provision of ‘unnecessary’ or ‘wasteful’ medical services even if doctors act in the perceived interests of their patients.
If a doctor inadvertently underestimates a patient’s ability to pay for the cost of medical procedures, the level of care recommended might exceed that which the patient would have nominated. However, some analysts maintain that doctors’ responses to clinical uncertainty can give rise to SID fully consistent with the patient’s interests rather than self-interest (Richardson and Peacock 1999, p. 9) e. g. use of diagnostics in excess of ‘standard’ levels in the event of diagnostic uncertainty. Institutional and regulatory arrangements influence how medical markets work.
They create incentives or disincentives for doctors (and patients) to behave in ways that could engender SID. For example, the cost-bearing and financing aspects of the doctor’s service are largely borne by third parties (i. e. governments and private insurers). As a consequence, typically neither the consumer nor the provider carefully considers the price or cost of the service supplied. This can influence the extent and form of SID. Other arrangements that can promote SID include: the system of payment for doctors (i. e. ee-for-service, capitation or salaried); the effect of medical indemnity arrangements on the adoption of ‘defensive medical practices’ by doctors; and the form of monitoring of doctor treatment practices. The link between physicians and pharmaceutical companies can also promote SID. Big pharmaceutical companies approach physicians and “ask” them to prescribe specific drugs to patients in exchange for a reward, such as free holidays. For example, in 2002 drug firms spent nearly $9. 4 billion on marketing to American doctors (The Economist 15th Feb. 2003). As a result, physicians are illing to prescribe extra medicines that are unnecessary and provide no benefit to the patient. Moreover, these drugs favoured by the physicians and produced by big companies might be more expensive than others with equivalent effectiveness However, one major criticism of the SID model is that it focuses on only one price– the nominal fee level–while ignoring access costs. If increased supply reduces travel time and office waits, the total cost of care has fallen even if fees remain constant. Secondly, the SID theory carries an implicit assumption that the extra services are unnecessary.
An alternative view is that few situations in medicine are clear-cut and a broad range of indications is consistent with generally acceptable practice. Empirical evidence of SID Several indirect hypotheses and empirical tests have been carried out but due to the lack of a rigorous theoretical model and the presence of econometric and measurement problems, results concerning the existence of SID still remain controversial and inconclusive. SID is not easy to measure and interpret because of the difficulty of separating out induced from un-induced demand, supply changes from demand changes and SID from other factors influencing demand (e. . income, insurance coverage, health status). However, there is clear evidence that physicians who are paid on fee-for-service basis can adjust the number of services in response to limitations on the levels of fees (Rice, 1983), but such responses are not automatic and health economists don’t have a good understanding of what contextual factors are important in predicting such responses. Nevertheless, the potential for such responses means that inducement is an important factor to consider in policy development. To test for SID early studies looked at changes in utilisation compared to increases in physician/population ratio.
The hypothesis underlying the tests is that, in response to an increase in the doctor/population ratio (i. e. competition), doctors will seek to induce demand or raise their fees so as to maintain their incomes. Cromwell and Mitchell (1986) demonstrated a significant demand inducement for surgical procedures with overall rates of surgery increase by about 0. 08% for each 1% increase in surgeon supply. Rice’s (1984) found that 10% decline in physician reimbursement led to a 6. 1% increase in intensity of medical services and a 2. 7% increase in intensity in surgical services.
However, a similar study found mixed responses to fee changes across procedures (Labelle et al 1990). Another technique used for testing SID is to examine the effect of changes in doctor supply on doctor compared with patient initiated visits. Assumption here is that if SID exists, increases in doctor numbers would lead to an increase in doctor-initiated visits (that is, an income maintenance response test). Tussing and Wojtowycz (1986), using this technique, found that areas with more GPs were associated with much larger proportion of return visits arranged by doctor, i. e. a strong relationship to support SID.
On the other hand, doing a similar experiment, Rossiter and Wilensky (1983) found only very small inducement effect. This approach to investigating the presence of SID effects (increasing physicians and increasing utilisation) fell somewhat out of favour when Dranove and Wehner (1994) found that, according to the standard methodology among SID theorists, an increase in the number of physicians resulted in an increase in childbirths. Recent studies have looked at physician behaviour in response to fee reduction, e. g. Yip (1998) found that physicians compensate for income losses due to public price reduction by increasing volume.
Medicare fee cuts lead to increased amounts of heart surgery enabling physicians to recoup 70% of lost revenue. Gruber and Owings (1996) found that a 13% reduction in fertility rate in the US in 1970-1982 led to an increase in caesarean sections and reduction in the less profitable vaginal births. Between 1971-1981, the number of GPs per capita in Winnipeg, Canada increased by 56%. Remarkably, however, real gross income per physician remained virtually unchanged during the period. GPs simply increased the number of contacts with existing patients – so much so that their average revenue actually increased (Roch et al 1985).
On the other hand, in Norway, Grytten and Sorensen (2001) compared a salaried group of physicians with another one that was compensated by fee for service. Neither of the two groups of physicians increased their output as a response to an increase in physician density. In UK, dentists are paid on a fixed fee-for-service basis. Supplier income can only be increased by increasing utilisation. Therefore, testing for the existence of SID in dentistry has involved looking for a positive correlation between dentist density and utilisation of dental care.
Birch (1988) concluded that a positive correlation between the number of dentists per capita and the treatment content per visit provides sufficient (but not necessary) evidence for the existence of SID, in a fee-regulated market environment. Other researchers [Manning and Phelps (1979); Grytten et al (1990)] found similar correlations. Sintonen and Maljanen (1995) found that individual and general inducement appeared to have considerable effect on utilisation, but no systematic connection with supply conditions (dentist/population ratio).
This was interpreted to indicate that some dentists, regardless of the market situation, have adopted individual inducement. However, there are alternative explanations for a positive correlation between dentist density and the utilisation of medical services: permanent access demand on the market for medical services due to price regulation; demand decisions by rational patients (the opening of new practices, particularly in rural areas, reduces the average time and transport costs, and the average time spent in the waiting room also falls); reversed causality where physicians set up shop in high demand regions (Zweifel 1981 p216).
Policy Implications of SID: SID is of great importance to the policy maker because it threatens the basic market paradigm and severely undermines economic recommendations about market policy. There are differing interpretations of policy significance of SID. According to Carlsen and Grytten (2000), policy makers can compute the socially optimal density of physicians without knowledge of SID. Yet most analysts look at SID from the perspective of manpower and reimbursement policy for purposes of cost containment. They do not consider its contribution to the health status of patients.
The impact of SID on equity, distributional issues and the net social benefits is usually ignored (Labelle et al 1994). The issue of SID raises another major controversy of whether adequate control over resource allocation to and within healthcare is best achieved through the demand side or through regulatory controls on the supply side (Reinhardt 1989, p. 339). Indeed, due to problems with moral hazard and SID, insurers use demand-side incentives (e. g. co-insurance and deductibles), as well as supply-side incentives aimed at providers (e. g. aying physicians through salary or capitation). An example of policy implications of SID to manpower planning is when a government wishes to attract physicians to rural areas, and it does so by paying rural doctors more than those in urban areas. This could precipitate SID within urban practices, hence nullifying the government’s intention. Direct regulation of the supply of physicians—by mandating that all new graduates spend a certain number of years in rural communities, for example —might have some advantages, although this may well affect the number and quality of medical students.
For facility planning purposes, Roemer’s Law has the fundamental implication that there is no external “demand” standard, based on observed utilisation, from which “needed” levels can be inferred. Providers will themselves determine use on the basis of available capacity inter alia. SID means increased demand by patients, which raises costs of care. If it exists, then the policy maker may wish to provide for control of supplier behaviour by mandating evidence-based medicine: cost-effectiveness evaluation of new interventions, medical audits etc, all of which encroach on clinical freedom.
Use of provider payment mechanisms like salaries for doctors, global budgets, and case payments could help. However, Ferguson (2002) argues that overall, demand curve for medical care slopes downward, and that supplier-induced demand is overrated as a policy concern. Conclusion: This essay has explained the rationale for the existence of SID and has explored its policy implications and empirical evidence of its existence. There is arguably sufficient evidence to accept that SID can occur. Even Hippocrates himself realised that as in all things mercenary (in health care it is “fee-for-service”) there is no such thing as pure altruism.
Indeed, the Hippocratic oath is an admission to the potential for pecuniary self-interest and abuse of sacred trust. Imperfect agency and clinical uncertainty are the main causes of SID. If SID is pervasive, there could be a variety of economy-wide impacts, e. g. it could increase health expenditure without a commensurate improvement in health outcomes. Therefore, it has important implications for the health policy process. Strong support for SID hypothesis was found in the UK dentistry. Otherwise, there is no robust evidence on the likely magnitude of SID.
Although inconclusive, most studies suggest that where SID arises, it is small both in absolute terms and relative to other influences. However, it is still worth considering SID-attenuating arrangements say in the case of physician reimbursement policy. As there are a number of fundamental and seemingly irresolvable methodological and data problems associated with trying to assess SID, definitive evidence of its existence most likely will remain illusive. References: 1. Arrow, K. J. (1963). Uncertainty and the Welfare Economics of Medical Care.
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Zweifel, P. (1981 p245-267). Supplier Induced Demand in a Model of Physician Behaviour. In van der Gaag, J. and Perlman, M. (eds), Health, Economics and Health Economics. Amsterdam: North-Holland ———————– P- fees for ServiceQ- supply of doctors S- supply curve of servicesD- demand curve for services P2 P1 Q1 Q2 D C A S1 S P3 P1 P2 Q1 Q2 Q3 Q4 D D2 D1 D3 S1 S B (a) No SID(b) With SID D

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